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Friday, March 21, 2014

5 Things To Ponder: Yellin' About Yellen

by Lance Roberts

The biggest news this past week was Janet Yellen's first post-FOMC meeting speech and press conference as the Federal Reserve Chairwoman. While I have the utmost respect for her accomplishments, every time I hear her speak all I can think of is my white haired, 75-year old grandmother baking cookies in her kitchen. This week's "Things To Ponder" covers several disparate takes on what she said, didn't say and the direction of the Federal Reserve from here.

In order to give these views context, I have included Yellen's post-meeting news conference. This is best viewed with a glass of milk and some warm, fresh chocolate-chip cookies...."just like Grandma used to make."

Quote Of The Day: "Bull Markets Are Just Like Sex, It Feels Best Just Before It Ends."by Barton Biggs

I have written many times in the past, most recently here, that the 6.5% unemployment target for the Federal Reserve was not a good measure of the true state of employment in the U.S. Specifically I stated:

"The difference between today, and 1978, is that in 1978 the LFPR was on the rise versus a sharp decline today. However, as I stated previously in 'Fed's Economic Projections - Myth vs Reality' this leaves the Federal Reserve in a bit of a predicament.

'The problem that the Fed will eventually face, with respect to their monetary policy decisions, is that effectively the economy could be running at 'full rates' of employment but with a very large pool of individuals excluded from the labor force. Of course, this also explains the continued rise in the number of individuals claiming disability and participating in the nutritional assistance programs. While the Fed could very well achieve its goal of fostering a 'full employment' rate of 6.5%, it certainly does not mean that 93.5% of working age Americans will be gainfully employed. It could well just be a victory in name only"

This is particularly the case when roughly 1 out of 3 people are no longer counted as part of the work force, 1-out-of-3 individuals are dependent on some sort of social support program, and over 17% of personal incomes are comprised of government transfers."

Howard points to the Federal Open Market Committee dropping its 6.5% unemployment rate threshold for raising the federal funds rate, a target originally set in December 2012.

"Instead it would look at some 'qualitative' measures, 'including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments,' the FOMC’s statement said."

This move shouldn’t have surprised anyone. The official unemployment rate was 6.7% in February and keeping that 6.5% target would have tied the Fed’s hands before it’s even finished tapering.

Yellen must deal with an economy that’s slowly recovering, but leaving a lot of people behind."

This is a very interesting take on a change in how the Fed presents its decisions and is worth reading in its entirety.

"Unless you have a crystal ball that tells you what will happen with wages, this possible new target tells you almost nothing about when rates will be raised.

These developments suggest a desire to turn the clock back to a time when traders had to make bets without Fed hand-holding -- even if the Fed still does release its economic projections. A shift toward opacity might be wise. The economy is a complex system that no one fully understands, so it would be foolish to commit to any unbending numerical rule that limits policy makers’ flexibility to react to unforeseen events. That was why former Chairman Alan Greenspan was opposed to formal inflation targets.

An additional benefit of opacity is reduced predictability. Scholars have found that financiers take too much riskwhen they think they know what will happen in the future, so muddying the waters may be just what’s needed to promote a safer financial system."

"In reality, the Fed will keep manufacturing excuses as to why rates can't be raised. Whether it's a cold winter or a hot summer, a geopolitical crisis, or an unexpected sell off in stocks or real estate, the Fed will always find a convenient excuse to postpone tightening. That's because it has built an economy completely dependent on zero % interest rates. Even the smallest rate shock could be enough to push us into recession. The Fed knows that, and it is hoping to keep the ugly truth hidden.

Although Yellen followed the script on the QE tapering, by decreasing monthly purchases by an additional $10 billion to $55 billion, look for her to abandon her commitment to wind it down to zero just as easily as she has walked back the Fed's commitment to raise rates once unemployment hits 6.5%. Any additional weaknesses in economic data, or dips in stock or real estate prices, will cause the Fed to call a time out on its tapering plan."

"Higher uncertainty premiums: The Fed is in the midst of not one but two policy transitions. It is pivoting from reliance on a direct instrument (QE purchases of securities in the marketplace) to an indirect one (forward policy guidance to convince others to devote their balance sheets) — thereby raising effectiveness questions. It is also moving from a readily-observable unemployment threshold to a set of indicators that include qualitative judgments — thereby raising less predictable interpretation questions.

Technical market conditions: Given the impressive multi-year rally, it doesn't take much these days to convince equity traders to book profits (and it hasn't taken long for buyers to buy on the dip). Similarly, over-extended front end rates positions can be destabilized in the immediate term even if the Fed is committed to maintaining low rates for long.

Reaction to the interest-rate selloff: With a significant part of the economy sensitive to short and intermediate interest rates, including housing, and with the economic recovery yet to broaden sufficiently, it is not surprising that the stock market would be concerned with a sharp selloff in the shorter-dated rates.

What about the longer-term?

Here, much depends on your assessment of the first factor — namely, Fed policy effectiveness during its policy transition. Unfortunately, there are no tested models, policy playbooks or historical data to confidently guide investors. What is clear, however, is that they will require quite a bit of evidence of ineffectiveness before abandoning their faith in an institution that has significantly supported markets in recent years."

Jason's articles are always worth reading and this is no exception. The "madness of crowds" is always relevant and prevalent. With the financial markets tied to the Federal Reserve, like a "fetus to its mother," these words of wisdom are worth remembering.

"In a guest essay published in the New York Times on Oct. 29, 1989, called 'Fear of a Crash Caused the Crash,' future Nobel Prize-winning economist Robert Shiller described a survey he had done of 101 market professionals the Monday and Tuesday after the tumble. Asked whether the drop was driven by 'a change in the stock market fundamentals' or 'psychology and emotion,' only 19% cited fundamentals; 77% blamed psychology and emotion. Shiller and his colleague William Feltus also asked the professionals if they thought the latest drop could turn into a replay of the 1987 crash; 35% thought it could, while 41% thought other investors thought so.

So, when KAL poked fun at traders overreacting to what others say, he was right on the money.

To this day, says KAL, brokers buying copies of the cartoon (featured above) 'inevitably' tell him, 'It was so funny because it was so true.'"